Posts Tagged ‘Cubic Feet’

(Thoughts on) Natural Gas

Thursday, May 17th, 2012

 

by Scott Ronalds, Steadyhand Investment Funds

We’re in one of the greatest bear markets of all time. In natural gas, that is. The commodity’s price has fallen from over $10 per thousand cubic feet (Mcf) in July 2008 to about $2.50 today. Last month, it touched $1.90, representing a decline of roughly 85% from peak to trough.

Natural gas is used to heat and cool homes and generate electricity. It is also used in the production of plastics, fabrics and fertilizers, and among other applications, can be used to run vehicles (although until recently it has been more expensive than gasoline). Further, it’s a cleaner fuel than coal, which is more commonly used in generating electricity.

Over the past few years, advancements in drilling techniques – notably hydraulic fracturing (“fracking”) and horizontal drilling – and new discoveries in shale rock formations in areas such as Louisiana, Arkansas, Texas and Pennsylvania, have led to a massive increase in supply. Promising fields are also being developed in B.C., Alberta, Quebec and New Brunswick. Estimates suggest the new fields south of the border could provide enough gas to satisfy U.S. demand for decades. And to think that in the mid 2000’s many experts thought production was in permanent decline.

Add a warm winter to the equation (roughly half of American homes are heated by natural gas), and the continent is currently swimming in the commodity. In fact, there are concerns that storage facilities will soon be full and producers will have to turn off the taps or dump gas.

It seems a shame. Natural gas is a cleaner alternative than many fossil fuels, yet it’s not being used in enough industries to soak up the massive inventories. The commodity sells for much more in Europe and Asia ($8 – $16/Mcf), but it’s not cheap or easy to transport overseas. Advocates of the fuel also see it as a way to fight climate change and reduce dependence on foreign oil.

Why aren’t more industries and businesses using natural gas? For one, it’s expensive to modify machinery, vehicles and service stations. Also, businesses can be tied into long-term contracts for coal or other fuels. And finally, there’s no guarantee it will remain a cheaper alternative to coal and gasoline.

There are radically different views on natural gas in the investment community. Some analysts believe that prices are bound to stay depressed, if not fall much further, because supply will continue to outstrip demand. Others feel that the spread between natural gas and oil prices is unsustainable (oil is currently about 40x more expensive; the historic norm is around 10x) and the commodity is sure to rebound as more industries make the change, more governments implement green incentives, and new facilities and technologies make it easier to export.

As a Steadyhand investor, you want to know what our managers think of natural gas and the role it plays in your portfolio. We break it down by fund below.

Income Fund

With respect to the fund’s income-equities, the manager’s focus (Connor, Clark & Lunn) is on companies that generate steady cash flows and have the financial strength to pay rising dividends. Because of the volatile nature of natural gas prices, direct producers typically don’t fit CC&L’s investment criteria. Natural gas producers do not generate stable income and the manager is not comfortable with the dividend sustainability of many of these businesses. Accordingly, they do not own any direct producers in the fund.

The portfolio does have limited exposure to the commodity through oil & gas service providers such as Enbridge and Gibson Energy. These are midstream businesses, meaning they are involved primarily in storing and transporting energy. Both companies, however, are more focused on oil than natural gas.

Equity Fund

CGOV Asset Management, the manager of the fund, feels that it’s anyone’s guess as to what will happen to natural gas prices in the short term. Gord O’Reilly (the lead manager) believes the magnitude of the price decline has been so great, however, that a reversion to the mean is likely over time, particularly as liquefied natural gas (LNG) export facilities come into production over the next few years (facilities have been approved in Louisiana and Kitimat) and more electric utilities and commercial vehicles convert to natural gas.

Yet, producers aren’t making profits at current prices and Gord feels it’s difficult to find value in the sector beyond CGOV’s two holdings, Birchcliff Energy and Pason Systems. Birchcliff is focused on natural gas exploration and production in Alberta (with some light oil production as well). The manager likes Birchcliff because it has valuable land assets and the ability to rapidly increase reserves. Their light oil production also helps pay the bills. The stock has been the subject of acquisition talk and has bounced around as a result. Pason provides rental oilfield instrumentation systems for oil & gas drilling and service rigs. Although low prices have hurt gas drilling, strong oil drilling activity has helped compensate.

Global Equity Fund

The natural gas landscape outside of North America is much different. The demand/supply equation is more balanced. The closure of nuclear power plants in Japan and Germany has added to demand, while a new wave of LNG coming out of the Asia-Pacific region and the Middle East has contributed to supply. Shale-related supplies are not as plentiful, however, due to inferior geology. Natural gas prices range from the equivalent of $11/Mcf in northwest Europe, to $13 in the Middle East and close to $16 in Japan. The manager of the fund, Edinburgh Partners Limited, believes that gas will play a greater role in the world’s longer-term energy mix, with demand growth concentrated in power generation and the ever-increasing global vehicle fleet.

The fund holds three investments with meaningful exposure to natural gas. Russian-based Gazprom holds the world’s largest natural gas reserves and owns the world’s largest gas transmission network. The company accounts for 15% of global gas output, supplies roughly 25% of Europe’s gas requirements and exports gas to more than 30 countries. ENI is an Italian-based energy conglomerate with a significant natural gas division that produces and sells the fuel throughout Europe and abroad. Petrobras is a Brazilian oil and gas producer and the 5th largest energy company in the world. Although its focus is more on oil, gas is an important division.

Small-Cap Equity Fund

While there are plenty of small-cap resource companies operating in western Canada, few natural gas-focused businesses represent attractive investment opportunities in the manager’s view (Wil Wutherich). Wil feels that stock valuations are expensive at current gas prices. Unless the price of the commodity rises to around $5/Mcf in the near term (Wutherich is skeptical of this happening), he believes that most companies will be hard-pressed to produce compelling profits.

Currently, the fund does not hold any pure natural gas producers. It does, however, own some companies with business divisions that are focused in part on natural gas. Of note, Total Energy Services provides drilling rigs and gas compression equipment to western Canadian producers. As well, Badger Daylighting provides excavation services that are used in the energy field for tank and pipeline cleaning, pipeline trenching, and repair and construction activities. Wutherich has a handful of other gas-related businesses that he knows well and watches closely, but feels they aren’t attractive investments at current prices.

Summary

If you hold a balanced portfolio of our funds (or the Founders Fund), you have modest exposure to natural gas. Our managers’ focus in North America is primarily on natural gas service providers that also serve the oil industry and therefore have a more diverse revenue base. CC&L, CGOV, and Wutherich & Co. are more cautious of direct producers (Birchcliff Energy provides the greatest direct exposure). The landscape is quite different outside North America, where natural gas prices can be 4-6X higher. The Global Equity Fund has holdings in Russia (Gazprom), Italy (ENI) and Brazil (Petrobras), providing you with diversified exposure to a number of international gas markets.

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“Don’t Frack Me Up” (Guest Post)

Friday, January 20th, 2012

Submitted by Marin Katusa of Casey Research

“Don’t Frack Me Up”

To many walking the planet, fracking has a seriously bad reputation. Thanks to hyperbole and misinformation, fracking opponents have convinced a lot of people that the operators who drill and then hydraulically fracture underground rock layers thumb their noses at and even hate the environment.

Anti-fracking claims may be twists on reality – for example, that a legislative loophole makes fracking exempt from the America’s Safe Drinking Water Act, when really this federal legislation never regulated fracking because it is a state concern. Then there’s the completely absurd, such as the idea that frac operators are allowed to and regularly do inject frac fluids directly into underground water supplies.

We decided to set the record straight by using facts, not playing on emotion like many of the frac-tivists do. It’s important because unconventional oil and gas constitute an increasingly pivotal part of the world’s energy scene. In the United States, where shale gas abounds but imported energy rules the day, this is especially true.

America’s shale deposits hold a heck of a lot of gas. According to the United States Geological Survey, the Marcellus Shale alone is home to 84 trillion cubic feet (TCF) of technically recoverable natural gas. Estimates of the amount of recoverable gas contained in all of America’s shale basins range as high as 3,000 TCF.

To access this gas, fluids made of water, sand, and chemicals to increase lubrication, inhibit corrosion of equipment, and possessing other qualities are pumped into the shale formation. When the pressure from the fluids exceeds the strength of the rocks, the rock fractures, and in a demonstration of might by the mighty small, the granules of sand prop the fractures open. Once the fracturing is completed, the internal pressure from the formation pushes the injected fluids to the surface again.

Frac wells are only open to the surrounding rock at the depth of the target formation. Starting at 250 feet (76 meters) or thereabouts above the producing interval – it varies a bit from state to state – the production casing must be cemented. This graphic, borrowed from the Texas Oil and Gas Association, shows what the procedure entails.

 

 

Casings are the liners that isolate the inside of the well from the surrounding rock, and from any

Casings are the liners that isolate the inside of the well from the surrounding rock, and from any water that might be contained in that rock. The surface casing is the first line of defense, while the production casing provides a second layer of protection for the groundwater.

Casings do require proper cementation to be effective: the cement seals the annular spaces between successive casing layers to provide a barrier to vertical and horizontal fluid movement. A poor cementation job was a significant factor in the Deepwater Horizon well blowout, and that transpired because deepwater regulations were insufficient. On land, however, cementation is highly regulated, and inspections of wells in progress, announced and unannounced, are common.

Unlike deepwater drilling, fracking is not new. Nor is fracking specific to natural gas or to the United States. Drillers frac many thousands of oil and gas wells around the world every year. In America, oil and gas producers have been using hydraulic fracturing since at least the 1940s to enhance recoveries from older oil wells and to access the oil in tight reservoirs, such as the Bakken.

Then there’s shale gas, a domestic source of energy for North America that’s much more reliable and secure than the millions of barrels of oil that come from places like Nigeria, Venezuela, Iraq, Angola, and Algeria every day. And as we’ve said, accessing that gas using hydraulic fracturing is much less dangerous and damaging than many people think.

Gasland – More Drama Than Documentary

Frac-bashing really took off last year, with the debut of the film Gasland. After receiving a letter offering his family US$100,000 for the right to drill frac wells on their land, a documentary film maker by the name of Josh Fox decided to investigate. Gasland is the product of that investigation, which took Fox to Pennsylvania, New York, Ohio, and West Virginia to interview other people living atop the newly discovered Marcellus Shale. Fox also visits Colorado, Wyoming, Utah, and Texas to talk to those who have been living alongside natural gas drilling for the last decade.

The resulting film is well crafted, dramatic, and emotional. However, documentaries are also supposed to convey context and a fair representation of the facts. That’s where Fox failed.

Let’s be clear: fracking is not without drawbacks (and more on that in a moment). What drives us Casey “Focused on Facts” Research types crazy is messing with the data. Some examples:

Fox “Fact”
Fracking Reality
An energy bill pushed through Congress by Dick Cheney in 2005 exempts the oil and gas industries from the Clean Water Act, the Clean Air Act, the Safe Drinking Water Act (SWDA), the Superfund Law, and about a dozen other regulations. The oil and gas industry is regulated by every single one of these laws except for the SDWA, which has never regulated oil and gas activities. If it seems these federal statutes do not sufficiently regulate fracking, that’s because the states do it instead.
Oil and gas drillers are allowed “to inject hazardous materials, unchecked, directly into or adjacent to underground water supplies.” Disposing of frac fluids is a challenge. One method does involve sending them down old natural gas wells, but the wells are always cased, cemented, and grouted where they pass through drinking water supplies to seal off contact with the surrounding rock and terminate in formations many thousands of feet below water reserves.
Drilling and fracking a well pollutes aquifers. The shales that contain natural gas are 5,000 to as much as 18,000 feet below ground. The aquifers we tap for drinking water are at about 500 feet. That means roughly 2 miles of rock lie between aquifer and frac. A 2010 report by Pennsylvania’s Department of Environmental Protection concluded “no groundwater pollution or disruption of underground sources of drinking water have been attributed to hydraulic fracturing of deep gas formations.”
Frac fluids are toxic mixtures of 596 deadly chemicals. Allowing for variance among companies and operations, fracking fluid is typically a bit under 91% water and 9% sand. Tiny amounts of added chemicals reduce friction, fight microbes, control pH, and prevent corrosion of equipment. Many are found around the house, including guar gum (in ice cream), borate salts (a fungicide), and mineral oil. And yes, there are 596 ingredients that have at some point been used to make frac fluids, but any single fracturing job uses only a few of the available options.

Figure 1. Composition of typical gas shale frac fluid (modified from Bohm et al., All Consulting, 2008a).
Drilling companies refuse to disclose just which deadly chemicals they use to create their frac fluids. Drilling companies must disclose the names of all chemicals stored and used at a drilling site. Anyone who knows how to read a Material Safety Data Sheet (MSDS) can find out what chemicals are present.
Fracking makes people’s drinking water flammable. It’s possible for improperly cemented wells to leak, but one study after another has failed to find frac fluid chemicals in drinking water supplies. Flammable tap water is more likely related to dissolved methane, which is naturally found in well water. (No worries here either – the methane bubbles out quickly, and the US Environmental Protection Agency does not even regulate it.)
Fracking is severely underregulated, and it’s because the industry has lobbied for and achieved so many regulatory exemptions. Fracking is very closely regulated, and reviews of fracking regulations regularly find them to be very rigorous. For example, the State Review of Oil and Natural Gas Environmental Regulations, an independent panel of environment, industry, and EPA personnel, found Pennsylvania’s fracking process was not only safe but “merits special recognition.”
Frac fluids that flow back out of a well are often stored in pits in the ground that aren’t even lined, where a lot of the fluid just seeps into the ground; even if they are lined, they often leak. Here Fox has finally hit upon some truth – that some pits have in the past leaked. That’s why they are being phased out in most states in favor of above-ground storage solutions that enable much better leak detection and repair capabilities. In fact, this month’s recommendation is a rapidly growing company with an innovative solution to storing frac fluids.
People who live near fracs have been found to have elevated levels of benzene in their blood. The only residents who had elevated benzene levels were those who smoked. Cigarettes contain benzene.
The EPA has never really studied fracking – the current study, which won’t even release its preliminary findings until the end of next year, is the first real environmental assessment of the practice. EPA started a study on hydraulic fracturing in 1999 that focused on coalbed methane reservoirs and whether fracturing them impacted underground sources of drinking water. Published in 2004 after peer review, the study concluded that fracking posed little to no risk in terms of contaminating drinking water.

Industry Efforts

As we alluded to earlier, fracking does has its drawbacks, two of which stand out in particular. The first is that hydraulic fracturing uses a fair chunk of water – an average multi-stage frac requires a total 5 million gallons of water. To put that number in context, electric generation uses nearly 150 million gallons per day in the Susquehanna River Basin of Pennsylvania.

Nonetheless, industry engineers are working hard to reduce water usage. After all, they know as well as anyone else what their livelihood depends on.

The most important shift here has been toward recycling frac fluids. In Pennsylvania, the fracking industry now reuses more than 60% of its water, for example. In addition, companies are exploring other, more creative water reduction strategies. In British Columbia, energy giant EnCana Corp (T.ECA) and its partner Apache Corp (NYSE.APA) spent nine months and C$10 million finding a deep, sour water aquifer and then figuring out how to make the super-salty, hydrogen sulfide-laced water usable for fracking. This novel technique could significantly reduce the need for fracking operations to use freshwater supplies.

The second drawback is that the fluids that flow back to the surface after a fracturing are often stored in containment units that have been known to leak.

As we pointed out, pits, lined or not, are being phased out in many jurisdictions, precisely because it’s truly difficult to tell whether a pit dug into the earth is leaking. This is where companies like  Poseidon Concepts (T.PSN) come in. Instead of lined pits and even the dozens of steel tanks that are the not-so-ideal alternative, PSN offers above-ground lined frames that are inexpensive and much more environmentally sound.

Another way to ease the problem of frac fluids spills or leaks is to make frac fluids so benign that we could literally drink them. It sounds pie-in-the-sky, but the world’s second-largest oilfield services company is working hard on the idea. In fact, Halliburton (NYSE.HAL) has created a frac fluid called CleanStim, made from materials sourced from the food industry. A Halliburton executive showed the stuff at a recent conference – and then tossed it down his gullet.

Where there’s a need, an innovator will rise to the challenge, and there are plenty of innovators in the world of oil and gas.

Fracking Earthquakes: Hazard or… Preventative?

A few weeks ago privately held Cuadrilla Resources, the first company to successfully frac natural gas shales in Europe and a Casey Energy team recommendation back in early 2008, announced that its fracking operations caused two small earthquakes in northwest England last April and May. After the earthquakes, Cuadrilla voluntarily suspended its fracking operations in the area while an independent group investigated the events.

The earthquakes measured 2.3 and 1.5 on the Richter scale. Seismic events, to be sure, but so gentle they were barely felt. Indeed, the independent report found that Cuadrilla’s work had caused the tremors, but the earth moved so little that they posed no threat to anyone or anything.

And what others may consider concern, we consider potential. As two plates of Earth’s crust naturally shift along their fault line, they can sometimes get hung up on rocky “hooks” called asperities. As the plates keep trying to move, stress builds and builds. The huge earthquakes we all fear occur when the stored energy has built enough to break through the asperity: the gradual slide becomes a destructive jerk.

Small tremors, on the other hand, reduce the pressure one bit at a time. Whenever there is a major earthquake or a discussion of when California or Vancouver or Japan will get hit with the next Big One, someone often laments, “If only we had a way to release the pressure beforehand!”

What if hydraulic fracturing could relieve the stress on the faults in earthquake-prone areas? Clearly the notion needs a battery of modeling and tests before it’s anything but a concept, but on a basic level the idea makes sense. Perhaps by releasing the accumulated stress at depth slowly with small tremors, we could mitigate the Big One enough that it might not be so big after all.

If nothing else, the concept is a reminder not to fear serendipity. Finding something you didn’t expect when attempting something else is how the scientific world achieved many of its major breakthroughs.

A Resource We Can’t Ignore

The ability to produce clean-burning natural gas from the 48 shale basins in 32 countries around the world could transform the global energy economy and increase energy security, starting in the United States.

Hydraulic fracturing has become a scapegoat, targeted by environmentalists as another attempt by the oil and gas industry to lock America into fossil fuel dependence. The thing is, America is already addicted to fossil fuels. Until that changes, even environmentalists will need to heat their homes, charge their cell phones, and purchase products made at gas-powered factories.

We of the Casey Research energy team are always looking for alternative energy ideas that stand the test of economics, but to date only geothermal and run-of-river power have come close. In the case of geothermal power, the industry has gotten ahead of itself and for now, at least, has failed to come through on its promises. As for run-of-river, the projects often work, but they provide only a drop into the big bucket of power needs, and each project requires major negotiations from landowners afflicted with NIMBY (“not in my back yard”) syndrome.

So next time someone says that America should put an end to fracking, ask them how they plan to ensure America’s energy security over the next 30 to 50 years. If the answer involves alternative or renewable energies, ask for some hard facts and numbers to support it. Like it or not, none of our alternative energies are as yet even close to stepping up as a major energy pillar for America.

Natural gas is ready to step up. It’s not a perfect solution – it’s much better at providing peak demand than baseload power, still takes energy to produce, and still produces greenhouse gases – but it’s an important part of the solution for now. Not only does America have the reserves, the fracturing process that can unlock them has been demonstrated as safe – and equally important, not demonstrated as not safe. And the industry that uses it seeks and incorporates improvements along the way. Just the facts, ma’am.

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Energy and Natural Resources Market Radar (November 21, 2011)

Saturday, November 19th, 2011

Energy and Natural Resources Market Radar (November 21, 2011)

Aluminum Supply Growth

Strengths

  • The Global Resources Fund’s exposure to paper & forest stocks helped performance this week and was one of the better performing industry groups in our natural resources universe.
  • The China Iron and Steel Association reported that crude steel output has continued to decline over the start of November, falling to an annualized rate of 607 million tons per annum from 627 million at the end of October. Accordingly, Chinese mills have responded quickly to weaker pricing and reduced production by more than 50 million tons per annum over September-October. This has helped bring the physical market back into balance, allowing steel prices to stabilize and market inventory to fall.
  • Royal Dutch Shell said that it has achieved the world’s deepest well completion on record in the Perdido development in the Gulf of Mexico. Shell said the Tobago field well was drilled in water depths to 9,627 feet and has started production.

Weaknesses

  • Both precious and industrial metals stocks underperformed our benchmark this week, which negatively impacted fund performance.
  • The price of natural gas fell to a 52-week low of $3.32 per million british thermal units, as inventory levels reached 3,850 billion cubic feet, or 6 percent above the 5-year average.
  • Despite breaking the $100 per barrel level, crude oil prices fell week-over-week to approximately $97 per barrel.
  • According to industry analysts, aluminum prices have dampened because of high inventories and weak growth prospects. Aluminum prices have tumbled nearly 20 percent in the past three months to around $2,165 per ton.

Opportunities

  • Mineweb highlighted that Peru’s regional government said that progress was being made in wage talks between Freeport McMoRan’s Cerro Verde and striking miners, who have just recently extended the strike to the third month. The regional government now believes the dispute at the mine that produces 2 percent of the world’s copper can be solved without government intervention, a possible sign President Ollanta Humala wants to stay out of the conflict.
  • Minter Ellison, a legal firm, has stated that the removal of the ban on uranium exports to India will present new opportunities and have huge implications to Australia. President Barack Obama visited Australia this week, leaving Australian Prime Minister Julia Gillard to put some hard lobbying into place to overturn a ban on supplying uranium to India.

Threats

  • Mineweb reported that BHP Billiton was wary on the commodity market outlook. The world’s biggest miner warned that some customers are starting to face tighter access to trade finance and some are cutting production. “The heightened volatility and uncertain economic outlook are expected to continue to weigh on sentiment in the markets” for commodities.

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Energy and Natural Resources Market Cheat Sheet (March 7, 2011)

Sunday, March 6th, 2011

Energy and Natural Resources Market Cheat Sheet (March 7, 2011)

United Nations Price Index

Strengths

  • Oil is trading at a 29-month high after rising 3 percent during the week. The unrest that has swept Africa and the Middle East, ignited by the ouster of the Tunisian and Egyptian leaders, has spread to Oman and Libya, raising concern production may be further disrupted.
  • The International Agency (IEA) this week reported that only 500,000 to 750,000 barrels of crude oil per day have been removed from the world market, which represents less than 1 percent of worldwide consumption. IEA stated that members have 145 days of emergency oil supplies in inventory.
  • China’s National Development and Reform comission reported this week that Turkmenistan had committed to supply approximately 2.1 trillion cubic feet of gas annually to China, up from the previously agreed 1.4 trillion cubic feet, and a deal would be formally signed in the second half of 2011. Turkmenistan’s deputy prime minister in charge of energy said talks were still ongoing between the two.
  • Platinum prices have traded above $1,800 an ounce so far this year.
  • Corn futures prices climbed to $7.24 per bushel, a 30-month high.

Weaknesses

  • Thermal coal prices at China’s Qinhuangdao port were 760-770 yuan per ton. Stockpiles at the port went up by 12 percent to 8.47 million tons.
  • Iron ore shipments from India will probably fall 25 percent to 64 million tones in the year starting April 1 from a revised forecast of 85 million tones this year, said the Federation of Indian Mineral Industries.

Opportunities

  • The global copper price will average $9,850 per ton in 2011, up 31 percent year-over-year, according to the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES).
  • Saudi Arabian Oil Minister Ali al-Naimi stated that his country and other OPEC members would offer extra crude supplies to offset lost Libyan production.
  • U.S. Interior Secretary Salazar said he hopes to approve a significant number of permits for deep water drilling in the Gulf of Mexico and the government will comply with court order to decide on five permits.
  • World food prices rose to a record in February and grain costs may continue to rise in the next several months, with only rice keeping the world from a repeat of the crisis three years ago, the United Nations said. An index of 55 food commodities rose 2.2 percent to 236 points from 230.7 in January, the eighth consecutive gain, the United Nation’s Food and Agriculture Organization said this week. Wheat rose as much as 58 percent on the Chicago Board of Trade in the past 12 months, corn gained 87 percent and rice added 6.5 percent. “I’ve never loved rice more than now,” said Abdolreza Abbassian, a senior economist at the FAO (Food and Agriculture Organization) in Rome.

Threats

  • China will find it difficult to stabilize prices this year although the nation will not see vicious inflation because it has sufficient reserves of agricultural commodities and has had bumper grain harvests, the China Securities Journal reported, citing Yao Jingyuan, Chief economist of the National Bureau of Statistics.
  • Rising oil prices driven by turmoil in North Africa and the Middle East may undermine eastern Europe’s economic recovery because industry in the former communist region is less energy efficient than in the west.

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Natural Gas: Better Days Ahead (in two years)

Tuesday, November 23rd, 2010

Natural gas posted the first weekly increase this month in the week of Nov. 14, on forecasts of colder than normal temperatures in most of the eastern U.S. from Nov. 24 through Nov. 28, which could spur an average 20 percentage rise above the normal heating demand.

Natural gas for December delivery ’ down 25 percent this year ’ gained 9.6 percent in one week to settle at $4.164 per Mmbtu on the NYMEX.

Temporary seasonal strength

However, this temporary seasonal strength does not alter the fact that U.S. gas stockpiles climbed to an unprecedented 3.843 trillion cubic feet in the week ended Nov. 12 ’ 9.3 percent above the five-year average level and 0.3 percent above last year’s level. (Fig. 1)

This storage glut has pushed U.S. natural gas at Henry Hub to its cheapest level in 11 months relative to Canadian gas (at 5 cents below), according to Bloomberg data. Henry Hub benchmark has been traded at an average of 85 cents premium to the Canadian benchmark AECO for the past 10 years.

Drowning in natgas?

As I said before, we are literally swimming in crude oil amid high inventory; but when it comes to natural gas, “drowning” would be a more appropriate description. While crude was hammered by China’s efforts to curb inflation, natural gas has an even bigger problem ’ nowhere to go ’ since it is region bound and not as widely traded.

Worse yet, the latest short-term outlook published on Nov.9 by the Dept. of Energy estimates natural gas production will rise in 2010 to the highest level in 37 years. Marketed natural gas production is forecast to increase by 2.5 percent this year, and fall by 1.2 percent in 2011.

However, the drop in 2011 is not because of a decrease in shale gas production, but mostly a result of a 13.5 percent production decline in GOM production from the 2010 drilling moratorium.

Shale surge

U.S. has seen a surge in natural gas output in the past two years (Fig. 2) with an increase in gas drilling from shale formations (Fig.3). During this time frame, the market equilibrium has been distorted mostly by drilling activities supported through joint ventures with foreign oil majors and national oil companies (NOCs), held by production lease (drill or lose), and producers’ favorable hedging positions.

Gas rig count has to drop

Some industry experts estimate that the gas rig count needs to see as much as a 20% drop ’ to around 750 ’ from the current 936 (as of Nov. 19) in the next 12 months just to keep production from growing.

The actual number of rigs required to hold production flat could even be lower due to the increased efficiency of new-generation high-tech rigs, and pad drilling.

Now, looking ahead, this rig count correction could actually start to take place by mid next year, supported by the following factors:

  • Operators are unlikely to find hedge support as favorable as that from the past.
  • Easing of Held by Production – most will be held by mid-2011.
  • Some cost carries from joint venture are beginning to run out.
  • Drilling shifted from gas to oil and liquid rich plays due to more attractive oil prices (Fig. 4).
  • Economics kicking in – since most shale gas wells need around $5 per mcf to meet returns.
  • Coal to gas switch from the power generation sector due to new EPA CO2 reduction rules and lower natural gas prices.

Unfortunately, the production boom of the past two years also means the price would remain sub-$5 for the next two years, amid the sub-par GDP growth and demand outlook (Fig. 5)… unless several Katrina’s end up landing on the Gulf Coast.

Glut set to last 10 years

Gas abundance is not limited to the U.S. The latest World Energy Outlook report by the International Energy Agency (IEA) released in early November basically threw the entire natural gas market under the bus by predicting the glut will worsen next year and last for 10 years, which will only fade gradually as demand rises strongly in China.

Future in LNG?

Nevertheless, news coming out of China is that the nation might see its natural gas supply fail to meet 35 percent of the demand in 2011, and the shortage could persist through 2021, according to China Business News.

Meanwhile, Platts reported that the significant arbitrage between UK ICE futures over U.S. prices ’ $3.357/MMBtu on November 8 ’ has landed the first LNG cargo in 50 years from the U.S. Sabine Pass re-export terminal on UK’s Isle of Grain import terminal.

While several import facilities were planned and built before unconventional gas even came into the picture in anticipation of high LNG imports in the coming decades, the U.S. has very limited LNG export capability. That could be about to change.

Two LNG export facilities were announced this year ’ Freeport LNG and Australia’s Macquarie Bank have agreed to build one in Texas to export 1.4 billion cubic feet per day of gas by 2015, and Cheniere Energy’s will be on the site of its Sabine Pass facility to export 16 million metric tons per year.  Both plan to produce and export LNG by 2015.

So, while natural gas’s green prospect is tied up in the legislative pipeline, it seems the more exciting aspect in the otherwise melancholy natural gas market could come from the LNG sector in the medium term.

Source: Dian Chu, Economic Forecasts and Opinions, November 21, 2010.

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Roundup: Energy and Natural Resources

Monday, January 4th, 2010

Energy and Natural Resources Market

WorldSteelIncrease

Strengths

  • The latest Steel Benchmarker assessments from World Steel Dynamics have shown a further surge in U.S. steel prices, with hot rolled coil up 2.6 percent to $590 per tonne from the previous assessment on December 14. The world export hot rolled coil price rose 3.4 percent to $534 per tonne, while #1 heavy melt scrap was up 4.7 percent to $261 per tonne. Western European prices bucked the general trend, with hot rolled coil falling 0.5 percent to $574 per tonne.

Weaknesses

  • Natural gas futures fell 2 percent this week on a weaker than expected inventory report released by the U.S. Department of Energy.

Opportunities

  • Over 50 percent of Codelco’s Chuquicamata mine workers voted to strike after a contentious contract negotiation, where Codelco ended up offering a 3.8 percent (started at 1 percent) salary increase over a 36-month period, plus bonuses in excess of Chilean Peso (CHP) 14 million or US$28,000 (started at CHP 10 million). The current contract expires on December 31, thus a strike at the Codelco Norte mine is expected to start on January 1, 2010.

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Threats

  • The U.S. Deptartment of Energy released EIA-914 production data for October 2009 which indicated a +1.1 billion cubic feet (Bcf) per day sequential increase in monthly production growth. With natural gas storage levels at 3,276 Bcf, 14 percent above the five-year average of 2,885 Bcf and 13 percent above last year’s level of 2,897 Bcf, the market is already oversupplied and sequential production growth remains an overhang to the price of natural gas.

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